Economists believe that prices are determined by supply and demand. They argue that, when supply exceeds demand, prices rise and vice versa. And, over the years, investors have found that this is particularly true for share prices.
Since the crash of 2007 to 2009, investors have considered stocks attractively priced and, accordingly, demand for stocks has exceeded supply, resulting in a rising trend in markets. But, every now and then, uncertainty (the possible break-up of the Eurozone, the Ukraine/Russian conflict etc) and fear returns to undermine confidence and nervous investors sell. This causes the supply of stock on the broader market to temporarily exceed demand and for prices to drop pretty much across the board. But when this fear subsides, selling wanes and demand again exceeds supply and stock prices advance again.
As noted above, the level of supply and demand for stocks as an asset class is affected by general market conditions, but individual stocks are also influenced by stock specific issues. The behaviour of Bank of Ireland (BOI) shares over recent years illustrates this well.
In mid 2013, the share price of BOI advanced as the outlook for the Irish economy and property market improved and prices rose from €0.15 to €0.38 by February 2014. But then, unexpectedly, a major shareholder, Wilbur Ross, a respected investor holding approximately ten per cent of the stock, announced he would sell his stake and the share price started falling.
The main reasons for the decline were firstly that a big block of shares, which heretofore were locked away were now back in circulation, increasing the supply of shares and secondly investors were concerned that such a large shareholder was exiting – it undermined confidence. As a result, BOI dropped all the way back to €0.24 by June 2014, even though the underlying prospects for BOI seemed to be improving.
Once the supply of stock placed by Wilbur Ross was absorbed by the market, BOI shares advanced and six months later (December 2014) had risen to €0.35. All looked well but then the stock fell away again. Why?
It emerged that BOI was planning to delist from the New York Stock Exchange. This delisting meant US investors would no longer be able to trade BOI shares in US dollars. This prompted some investors to sell, as they were not interested in a stock they could not trade easily. This selling exerted downward pressure on the share price and, by mid February 2015, it had declined all the way down to €0.26. Again the decline didn’t seem justified by any real change in business prospects.
So it was no surprise, when BOI shares started to rise again as selling by US investors subsided and supply/ demand levels returned to normal. Prices today, only one month later, are back up to €0.35.
So where to next for BOI? Well, the speed of the recent recovery is a positive omen but in the longer term its direction will be heavily influenced by the performance of the Irish economy as this is critical to bank profitability. As Warren Buffett once observed, ‘If a business does well, the stock eventually follows.’
In the interests of full disclosure, the author wishes to disclose that he has a holding in BOI.